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Pull the other leg, Mr Chancellor

Yesterday saw the arrival of the Budget we had all been waiting for. How was Alistair Darling, the chancellor, going to deal with an economy which is in severe recession and contend with government finances which have been so severely overstretched?

 

There was a bit of tinkering here and there with slight increases in taxes on alcohol, tobacco and petrol, some additional help for businesses and a “green” car-scrapping scheme. These were the small numbers. However, it is the big numbers that we should be interested in.

 

The chancellor predicted that the UK economy will contract by 3.5% this year, but next year it would revive, growing at 1.25%, followed by a 3.5% ongoing growth rate from 2011. Is this possible? Well, anything is possible, but this appears ‘unlikely’. Even yesterday the IMF published figures which forecast that UK growth will fall 4.1% this year and will continue to contract in 2010 by 0.4%.

 

Obviously, these growth figures have important implication for government borrowing. The faster the economy returns to trend, the faster government revenues perk up and the less that government has to spend on increased welfare and other benefits. However, even given his somewhat rosy forecast, the chancellor said that public borrowing will have to rise to £175bn this year – which would be 12.4% of gross domestic product – falling to £173bn next year and £140bn the year after. As David Cameron pointed out, borrowing over the next two years will total more than all previous UK governments put together. 

 

At the same time net debt is forecast to rise from 59% of GDP in 2009-10 to 79% of GDP by 2013-14. On the spending side, growth in real spending on public services is to be cut from a planned level of 1.2% a year after 2010-11 to 0.7%. As far as investment is concerned, the small print shows that government investment this year will be 1.5% and will increase to 2.0% next year, but in 2011 it will fall by a massive 16.25%.

 

Oh, almost forgot, one way the government is hoping to increase taxation is to impose a new 50% top rate of income tax on those earning over £150,000 a year which will be introduced in April next year. These same people will also lose some of their tax relief on pension payments from the following year. These measures are due to bring in £1.23bn in 2010-11 and £2.2bn in 2011-12. So, nearly £3.5bn extra coming into the exchequer, if these figures are accurate. Doesn’t seem that much against almost £500bn of borrowing over the same period.

 

The main question is, will the government be able to borrow this much money? Are we going to print it? If so, there will be serious inflationary repercussions. Are we going to borrow it from UK lenders through the issue of gilts? If so, this is likely to put such a dent in savings that it will crowd out private sector investment? Are we going to borrow it from abroad? If so, who will want to lend to us and how will we pay it back?

 

The second question is, what will happen if the chancellor’s growth figures are as over-optimistic as most forecasters believe? The answer is that we will have to tax more, spend less and borrow even greater amounts. What are the consequences of this? Just revisit the main question again in the paragraph above but worry more.

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Posted in crowding out, government borrowing, Investment, Public Finances, taxation

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